Stock Analysis

Calculating The Fair Value Of Vista Outdoor Inc. (NYSE:VSTO)

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NYSE:VSTO
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Does the August share price for Vista Outdoor Inc. (NYSE:VSTO) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Vista Outdoor

The model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$265.6m US$212.0m US$182.6m US$166.0m US$156.4m US$151.0m US$148.2m US$147.2m US$147.4m US$148.4m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -13.87% Est @ -9.11% Est @ -5.78% Est @ -3.45% Est @ -1.82% Est @ -0.68% Est @ 0.12% Est @ 0.68%
Present Value ($, Millions) Discounted @ 9.0% US$244 US$179 US$141 US$118 US$102 US$90.1 US$81.2 US$74.0 US$68.0 US$62.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.2b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.0%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$148m× (1 + 2.0%) ÷ (9.0%– 2.0%) = US$2.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.2b÷ ( 1 + 9.0%)10= US$917m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$2.1b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$40.4, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
NYSE:VSTO Discounted Cash Flow August 2nd 2021

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Vista Outdoor as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 9.0%, which is based on a levered beta of 1.481. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Vista Outdoor, we've compiled three additional items you should consider:

  1. Risks: We feel that you should assess the 3 warning signs for Vista Outdoor (1 shouldn't be ignored!) we've flagged before making an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for VSTO's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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